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Overbought Territory?

I have a diffusion indicator I use, and it’s telling me we’re probably near the peak of the current short-term rally. Is it predictive? Sometimes. Except when it’s not.

Click to enlarge.

This is calculated by recording the diffusion ratio of all the stocks in the Russell 3000 index that are up 20% or more in 20 days, vs those that are down 20% or more in 20 days. [ up ÷ (up+down) ] I then calculate a short-term momentum function to generate the curve you see in blue. Overlaid with this in red is the SPY ETF price, a proxy for the S&P 500. Note that when the blue line dips below .75, everything seems to go pear-shaped in the days following.

Add to the fact that some of the indexes have hit all-time highs today, and, well…

Time to hang up the short-term momentum trades and prepare for the short-term mean-reversion trades instead!